The Incredible Shrunken Headhunters

March 10, 2002

Beginning in the mid-1990s, executive-recruiting firms hit the equivalent of a Las Vegas jackpot as clients desperate for talent dialed headhunters for help. Revenues at top firms such as Heidrick & Struggles (HSII) and Korn/Ferry (KFY) grew 24% a year on average between 1995 and 1999. And 2000 was the best year ever for the search industry, whose revenues grew 30%, or to about $1.7 billion for the top 25 U.S. firms, according to industry research company Hunt-Scanlon in Stamford, Conn.

Executive-search consultants, as headhunters began calling themselves, assumed a status akin to that of Hollywood agents, wheedling and dealing for multi-million dollar contracts for CEOs and even lesser corporate stars. To capitalize on their good fortune, No. 1 Korn/Ferry and No. 2 Heidrick went public in 1999 after decades as private companies.

WAITING BY THE PHONE. Then came last year -- and with it a dose of reality. Search-firm revenues fell 25%, on average -- the first decline in a decade -- as clients who only months before had been desperate for talent sought with equal desperation to cut costs. A shortage of executives quickly turned into a glut, as Corporate America laid off 2.5 million employees. This year, the phones were supposed to start ringing again. But with the economy just beginning to recover and the Enron scandal adding uncertainty, recruiting-company switchboards aren't yet overheating.

In fact, Peter Felix, head of the Association of Executive Search Consultants in New York, a trade group representing 160 headhunters worldwide, says many recruiters now expect zero revenue growth this year vs. last. "Search consultants are still sitting on their hands," says Felix.

Indeed, hiring companies are wary of bringing in new staff until they see persuasive signs that business is coming back. Some 73% of 150 senior executives from 130 top U.S. outfits said in a January survey by Dallas search firm The Broadmoor Group that they plan to do no more hiring this year than last. Some 8% of the respondents said they will lay off more employees, while only 19% said they intend to add to their executive payrolls -- a decision they can easily reverse. Felix says that one major search firm recently landed four plum assignments -- only to have the hiring company call back several days later and put them on ice. "The last few weeks haven't been very encouraging," Felix says.

"CLIENTS ARE HOLDING BACK." As hiring goes, so go the fortunes of the recruiting firms, which typically collect a fee equal to one-third of a placed exec's first-year cash compensation. "I'm looking for things to stabilize in the second half of 2002," says Kelly Flynn, business and professional-services analyst at UBS Warburg in New York. "But even if that happens, revenues will be down this year compared with last."

Just ask Chicago-based Heidrick, which next year will celebrate 50 years in business. In 2001, the company lost $47 million on revenues of $455.5 million, vs. profits of $19.4 million on revenues of $594 million in 2000. It performed 36% fewer searches in 2001 -- 4,966 vs. 7,816. "We've heard from our people from offices around the world that clients are holding back," says spokesman Eric Sodorff, who notes that the company expects further erosion in revenues for its year ending next December -- to around $420 million. Yet he adds: "At some point, the clients will need to move on with their hiring. It should turn around before too long."

The story is similar at Los Angeles-based Korn/Ferry. Mark Marcon, a senior business analyst with Wachovia Securities, expects the firm to lose $11.5 million, excluding charges, for its fiscal 2002 year ending Apr. 30 on revenues of $418.7 million vs. profits of 31 million, excluding charges, on revenues of $653.7 million for its fiscal year 2001. "We think that the very near-term outlook [for Korn/Ferry] continues to be muted from a demand perspective," says Marcon. "But it certainly appears that the economy is on a recovery path and the back half of this year and next year appears more promising for recruiters."

VACANCIES DOWN, FEES UP. Jim Boone, Korn/Ferry's president of the Americas, agrees the business is nearing a bottom. "The economy is showing gradual improvement," he notes, and "looking at our crystal ball, we think we should show improvement." But only after months of pain. Over the past year, Korn/Ferry has cut its staff by about 20%, while Heidrick has shrunk by about 16%.

Not all recruiting has come to a standstill, of course. Not-for-profits, health-care companies, and businesses looking for executives with experience in corporate security have kept the search firms going. Surprisingly resilient, as well, has been the demand for so-called C-level executives, such as chief executives and chief financial officers. Even though Heidrick's confirmed number of searches dropped 54% in the fourth quarter of 2001, its fees per search rose 28% for the period because recruiting for top managers made up a larger proportion of its business. That reflects a new kind of desperation: "A lot of companies are trying to find the exec who will be the answer to all their problems," says Felix.

This has provided at least a temporary opening for some boutique search firms, which like to bill themselves as experts at so-called custom searches. "Companies want a tailor to help them get exactly the right talent instead of off the rack merchandise," says Mark Jaffe, a partner at Wyatt & Jaffe, an executive search firm in Minneapolis with three recruiters. Jaffe's company suffered a 40% decline in revenues last year, to about $1.2 million, but is expecting a 10% to 15% improvement this year. Business is "going to pick up slowly," Jaffe says.

SLOW TO HIRE? The first beneficiaries of an economic upturn are expected to be the search and staffing firms that fill temporary jobs. Before companies hire full-timers, "they'll bring on contractors to finish critical projects and to get certain technology skills," says Scot Melland, president and chief executive of New York-based Dice, the largest online job board for technology professionals. Since mid-December, Dice's job listings have risen 10%, to 31,000, Melland says, a trend that could mean the economy is on the mend. "It's the first time in 12 months that we've seen a rise in job postings," he notes.

Some skeptics believe that even after the economy rebounds, executive recruiters may have a tougher time drumming up business. After being burned by the recession, for instance, client companies will likely take care to avoid hiring too quickly. And Paul Bernard, a career coach who counsels mid- to senior-level executives and is president of Paul Bernard & Assoc. in New York, thinks employers will beef up in-house recruiting before they resume paying big fees to outside firms.

One company Bernard works with paid $700,000 in fees to prominent recruiters in 2000 -- with disappointing results. "Many of these people were terrible hires, and many were let go during the downswing," he adds. Having lived through that, "more companies are going to say, 'Why use a recruiter?'"

REASSURING DEMOGRAPHICS. Still, recruiters and the analysts who cover them maintain that their future is bright. They argue that in-house recruiters are no match for headhunters, who usually have a broader range of contacts and experience. And because top recruiting outfits pay so well, the most talented search professionals naturally gravitate there, they add. "I'm sure that during this downturn we'll see a weeding-out in the industry, and that isn't a bad thing," says the Association of Executive Search Consultants' Felix. "The good search consultants who provide quality service and have a good relationship with their clients will always be in demand."

What's more, demographics are in the search firms' favor. In coming years, companies will need help to get the best employees as they face a shrinking labor pool: The 77 million Baby Boomers, the oldest of which will begin retiring in the next eight to 10 years, will be followed by Gen X-ers, who number a scant 44 million. In the resulting tight job market, "a lot of workers are going to have to recruited," says Marcon.

And that's good news -- not just for headhunters, but for everyone else who'll be looking for a job. By Eric Wahlgren in New York